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Brazil: the debt markets continue to deliver, and with good reasons

In this article, we show that holding Brazilian sovereign and local debt is fundamentally equivalent to betting on a downward trend in the long-term volatility of the Brazilian real (in contrast to short-term volatility). This volatility is merely the reflection of economic outlook. It tends to increase in anticipation of a cyclical downturn and decrease in anticipation of a recovery.

Given that the current recovery is likely to continue thanks to the recent sharp drop in the rate of inflation, which has strengthened real income, and the easing of lending conditions engineered by the BCB (Brazil’s central bank), we remain optimistic on these two asset classes. Barring a significant worsening of the political situation, which threatens to bring all reform efforts to a halt, and assuming that commodity prices will remain stable or even increase, Brazilian debt assets offer an attractive proposition. Yield to maturity on local debt at 10% remains protective, and Brazil’s sovereign spread should decrease by a further 60 bp from its current level